(FORTUNE Small Business) – One solution to America's energy crisis just may be gobbling away at a poultry farm near you. Changing World Technologies has developed a working system to convert turkey guts and scraps into fuel oil. But CWT's tribulations show how hard it is for even the most innovative green company to compete in the energy business.

CWT's improbable alchemy is based on an idea that scientists have been kicking around for three decades: mimicking the earth's process for creating oil and gas. By subjecting organic materials to extreme heat and pressure, CWT produces in minutes what the planet takes thousands of years to make. The company says its process works on tires, various hazardous wastes, and plastic as well as heavy metals.

The key question is whether the end products are pure enough and cheap enough to compete with other biofuels and petroleum. Until recently it seemed that turkey fuel would score big on both counts. CWT saw opportunity in the mad cow scare of December 2003. Expecting U.S. authorities to ban the feeding of animal offal to livestock—a practice linked to mad cow disease—CWT and ConAgra formed a joint venture that built a $30 million plant in Carthage, Mo. The venture assumed that nearby turkey processors would provide lots of free turkey waste. Last year the Carthage plant began selling its output to a Midwestern manufacturer, which buys it for roughly $40 a barrel (25% less than conventional fuel) and uses it to run its plant. The Carthage factory now produces 400 barrels a day.

That's a drop in the ocean of U.S. oil consumption, currently running around 20 million barrels a day. But making more turkey fuel isn't as hard as nailing down its costs. It turns out that feeding animals to animals remains standard practice in the U.S., despite a modest tightening in the regulations last year. So instead of being free, turkey leftovers cost $30 to $40 a ton, a hefty expense considering that one ton of turkey yields just two barrels of oil.

And turkey fuel has so far been excluded from biofuel tax breaks. In October, Congress passed a bill that gave biodiesel, which is also derived from biological material, such as soybean oil and animal fat, but has a different chemical composition, a tax incentive that translates into a $1-a-gallon break on production costs. "The good news is that the government finally gave an incentive for producing fuel from waste," says CWT chairman and CEO Brian Appel. "The bad news is that it narrowly defined the kind of fuel receiving the incentive."

As a result of those two setbacks, CWT's production costs have doubled, to nearly $80 a barrel, a crippling blow given that conventional diesel sells for about $50 a barrel. CWT is staying afloat, thanks to a $10 million grant from the U.S. Department of Energy. But the company's next operation is likely to be in Europe, where food processors will pay to have CWT dispose of animal offal and where most governments offer tax incentives to biofuel producers. Appel is negotiating to license CWT's technology to Irish Food Processors, one of Europe's largest, which plans to build a biofuel facility by the end of 2006.